3/28/2005 @ 12:00AM

The Long Good-Bye

Congress makes another grab at expats’ money.

For more than a decade Congress has obsessed over the fact that a handful of rich folks, including fund operator John Templeton, Kenneth Dart of Dart Container and Campbell soup heir John Dorrance III were able to escape U.S. income and estate taxes by renouncing their citizenship.

So in October, as part of a big corporate tax act, the politicians took yet another shot at fleeing turncoats. They tightened up a 1996 law that is supposed to extract ten years of taxes from tax-motivated expatriates as they head for the airport. The new, tougher version will cause pain for some moderately well-off expatriates. But the truly rich and tax averse will still be able to plan around it.

Under the old law expatriates could apply to the Internal Revenue Service for a ruling confirming they had left the U.S. for nontax reasons and were therefore exempt from the ten-year levy. That was a loophole through which you could sail a 100-foot yacht. Half the 270 people who applied between 1997 and July 2002 got favorable rulings and only 11 got unfavorable ones. The rest got “neutral” rulings, which allowed them to proceed as if they didn’t owe the tax. In theory the IRScould later audit the “neutral” folks and assess a tax, but there’s little evidence this happened.

The ruling loophole is now closed. Under the new law, which is retroactive to June 4, 2004, anyone who expatriates and has assets of more than $2 million or paid more than $620,000 in federal income taxes over the five years before leaving is presumed to have left for tax reasons. Only certain dual citizens and minors with few ties to the U.S. can get exemptions from the ten years of tax.

Expatriates who don’t fit one of these narrow exceptions will owe U.S. income tax on a wide range of U.S. source income and estate and gift taxes on U.S. assets for ten years. If they spend more than 30 days in the U.S. during any one of those ten years, they’ll be taxed that year just like U.S. citizens, on all their income from any source. “This is the stinger in the tail,” says Dyke Davies, a tax lawyer with Bryan Cave in London. Warning to ailing expatriates: Don’t come here for medical treatment; if an expat dies in a year where he’s spent 30 days or more here, his entire estate is subject to U.S. estate tax.

The new law also requires post-June 3, 2004 expats to file extensive disclosures–worldwide income, days in the U.S., etc.–with the IRS, annually, for ten years. This is going to be irksome to people who settle abroad and later expatriate because they get tired of paying accountants’ and lawyers’ fees to comply with U.S. as well as, say, U.K. law, says Davies. “Lots of people give up U.S. citizenship because the compliance drives them nuts,” she says. “Now they will still have compliance costs for ten years.”

One last consideration: A separate 1996 law bars citizens who expatriate for tax reasons from returning to the U.S. Now that so many folks will technically be considered to have left for tax reasons, it could be a threat. “People are nervous,” says Loretta Ippolito, an international tax lawyer with Willkie Farr & Gallagher in New York. “They don’t want to take the chance they can’t come back to visit their family or for business.”

The good news, if you are contemplating leaving for tax reasons, is that the new law isn’t the feared “exit tax” that was passed by the Senate. And it still leaves huge holes that the rich and well-advised can use to avoid paying U.S. tax. “For someone wealthy enough that expatriation tax is an issue, it’s worth paying someone to avoid it,” says Richard LeVine, an international tax lawyer with Withers Bergman in New Haven, Conn.

A wealthy expatriate can simply hold on to assets, such as U.S. publicly traded stock, avoiding gains tax for that ten-year period. Or he can invest through variable annuities whose payout is deferred for at least a decade. And if he controls a U.S. C corporation, he can defer paying himself dividends. What if he needs cash sooner? He can borrow against his U.S. assets. (Loan proceeds don’t count as income.)

To avoid being subject to the U.S. estate tax an expat has to live for more than ten years after expatriation or die in 2010–the year in which the U.S. estate tax disappears for one year. But he can minimize his estate’s potential bill during that ten-year window by using some of the same techniques wealthy U.S. citizens use, such as family limited partnerships.

It would have been harder to get around theSenate-passed exit tax. Under that system, upon departure expats would have had to pay a one-time tax on all unrealized gain, beyond a $600,000 exemption. Planning note: The new law requires the Treasury to report on its effectiveness after its first year. If it looks as if the 2004 law isn’t raising the projected $377 million of revenue over ten years, or if Congress is casting about for more cash, the exit tax idea could be revived. So if you plan to expatriate, pack now.